Why is Bitcoin a better asset class than real estate
Bitcoin is all over the news right now. Again. Since the start of the global COVID-19 pandemic, after falling briefly from around $10k to under $4k in mid-March 2020, it has seen a massive rally to its latest all-time-high of just a bit more than $64k in April 2021. The antagonists of Bitcoin, who are either the representatives of the conservative community of the financial industry (most of the bankers, pension and hedge fund managers, financial advisors, etc.), or people who have zero clue about Bitcoin and how the technology behind it works, or the mixture of both, keep telling its just another bubble, a Ponzi scheme, etc. The Bitcoin evangelists, crypto-traders, and tech entrepreneurs who do understand the technology behind Bitcoin, as well as some random FOMO (fear of missing out) retail investors praise the current run and believe it is just the beginning. One can be sure — with the world’s leading companies from various industries and institutional investors heavily investing in Bitcoin or building services around it mainly since 2020 — Tesla, Microstrategy, Visa, Square, Fidelity, PayPal, Galaxy Digital Holdings, Grayscale, BlackRock, Goldman Sachs, J.P. Morgan, etc. to name just a few, Bitcoin is here to stay and became an asset too big to fail.
The main narrative of Bitcoin’s intrinsic value is that it is a better version of gold, the main reserve asset. Why? Because it is scarce, peer-to-peer, fully decentralized, runs on a public ledger, and can be easily transferred from one part of the world to another within some minutes and at a cost of two burgers. This makes it a great SOV (store of value). Furthermore, the ability of Bitcoin to be divided into tiny fractions, called Satoshis (1 Bitcoin = 100.000.000 Satoshis), makes it also a great medium of exchange. But is Bitcoin really better than real estate, the so much beloved asset class? In my humble opinion, — yes, it is. So let’s check out why.
What defines an asset class?
First, let’s analyze what is an asset class. An asset is a valuable object owned by an individual or a company. Since assets represent value to individuals and businesses, they have two main functions — a store of value and a medium of exchange for goods and services. Due to their different characteristics, some serve better as an SOV, the others as a medium of exchange.
The main characteristics which define an asset are — risk, return, liquidity, legal regulations. Therefore, an asset class is a group of assets that have similar characteristics. Here are some of the most common asset classes:
- Equity — stocks in private or public companies; the potential returns on stocks are represented by the dividends (your share of the earnings) and the stock price growth;
- Bonds — units of corporate or government debt issued with fixed interest;
- Commodities — oil, gold, silver, coal, cotton, lumber, coffee beans, and other types of primary-industry exchange-traded goods used in production and manufacturing of other end-consumer goods;
- Derivatives — secondary financial instruments, such as futures contracts, options, forwards, etc. which have primary financial instruments, e.g. stocks or bonds as underlying assets;
- Cash — in different national currencies, which is considered to be the best means of exchange;
- Real estate — commercial, residential, industrial, agricultural, or raw land, which is considered to be the best SOV since it is limited and humans know exactly how much land is available; the potential returns are based on the rental payments and price increase;
- Cryptocurrencies — bitcoin, ethereum, and numerous other crypto assets which are a relatively young asset class and are still in the process of adoption.
All of these asset classes have different levels of risks, potential returns, liquidity, regulation, and react differently to macroeconomic events. An in-depth analysis of all these asset classes, the differences in their main characteristic features, as well as their roles in portfolio allocations and reaction to different macroeconomic events, is a topic big enough for a separate book. In this article, we will focus on the similarities and differences between real estate and bitcoin.
Real Estate
Real estate is considered to be the best store of value because of its main fundamental — there is limited space on Earth and the world population is increasing, therefore, in an inflation-based economy, the price of real estate should always go up in the long term. Of course, the price depends on many different factors, such as country, city, type, population growth, financing opportunities, taxation, market conditions, etc., but one can be agreed, is that when people’s income rate increases, at some point, they want to afford a better housing — a nicer flat, a bigger house in a better neighborhood, a holiday apartment somewhere at the seaside, etc.
Based on this fundamental, almost every investor has different kinds of real estate properties as a part of their portfolio. But what does it really mean to own and manage real estate? Do the prices really always go up? Let’s have a closer look at it.
Price. The price for real estate is highly dependent on the location, type, population growth, and financing possibilities. For example, cities with flourishing economies and high standards of living attract more and more people and, therefore, have a growing housing demand which leads to real estate price growth. At the same time, low-interest rates which may be a part of a government’s monetary policy aimed at fostering economic activity, create an incentive to take mortgages with fixed interest which also leads to higher demand and higher prices. On the other hand, political instability, economic recession, or armed conflicts can drive real estate prices significantly down in a matter of days. Generally, political and economic stability plays a huge role in long-term real estate price developments. With the COVID-19 pandemic, the real estate market experienced a heavy disruption. Due to lockdowns, numerous companies (mostly in the tech industry) shifted to a remote-only working policy, allowing their employees not to come back to the office at all. As a result, the prices for commercial real estate went down significantly. Furthermore, the need to live in more expensive states disappeared which led to people moving out of Silicon Valley or New York, and, therefore, the prices on residential real estate in these areas go down. Last but not least, people started to value living in nature more, since the need for long commuting hours disappeared, so the prices for land plots or country houses went up.
Returns. Real estate can bring relatively stable returns from rental income. Residential real estate can be rented out either long-term, which is more stable, or short-term via different platforms such as Airbnb, which has a higher ratio of income per night but needs additional investment to ensure that the property is booked. Furthermore, real estate can bring additional returns in case of sale after price appreciation. Having a constant growth of global population and better housing and living conditions as one of the basic human needs, we can assume, that the price of real estate always goes up, except the events of global imbalances, such as economic downturns, political instability, armed conflicts, etc.
Liquidity. One of the disadvantages of real estate is that it has low liquidity. If you need to convert your real estate object into cash quickly, you will need to offer it at a significant discount. The time of your object being on sale on the market highly depends on the type of the object, its size, location, etc. When the buyer is found, the process of property rights transfer will take from days to weeks, so it has to be added to the time of the market what impacts the liquidity. Furthermore, its liquidity can highly depend on the current economic situation — if people believe their objects are currently undervalued, they will not sell them.
Supply. The amount of land is ultimately limited — there will never be more land than there is on our planet. Regarding the supply of commercial and residential real estate — it is relatively limited and is defined by the demand and supply. With the growth of population, the demand for residential real estate grows. Regarding the supply of commercial real estate, it is driven by the demand for factories, office buildings, etc. Both types need to be built first and are highly regulated by the governments — the governments are regulating how much and which kind of properties can be built when, where, and how.
Risks. Like any other asset, real estate has its own risk. First of all, as a physical asset, it underlies a risk of being damaged, e.g. by rentees or natural calamities, or completely destroyed, e.g. in case of war, etc. Secondly, real estate underlies an amortization — the properties are getting older and need constant maintenance. Thirdly, there are regulatory risks, e.g. a possibility of additional taxation for owning real estate which will lead to people selling their excessive properties.
Regulation.
The supply of real estate, as well as its posession is highly regulated and differs from jurisdiction to jurisdiction. As a business or an individual, you have to obtain special permissions in order to invest, whether to build or buy, in real estate in certain countries. Some countries also restrict the amount, type, and place of real estate which you are allowed to own, e.g. buying beach front-line land spots may be restricted, etc.
Bitcoin
Bitcoin is a fully-decentralized, peer-to-peer, proof-of-work based deflationary crypto-asset with zero counter-party risk created by an anonymous software developer and cypherpunk known under a pseudonym of Satoshi Nakamoto in 2008 and first described in a White Paper as an electronic cash system which can run independently from the current financial system. The idea of Bitcoin was born right after the Great Recession of 2007–2009, when due to burst of real estate pricing bubble caused by excessive subprime mortgages, moral hazards, as well as systemic failures in the financial system, the prices of all major assets fell down significantly. The crisis raized attention to an underlying problem of the current financial system — bailouts of numerous banks and corporations who governments saw as “too big to fail”, in order to prevent a full collapse of the financial system, but who at the same time, directly or indirectly caused the bubble and had close ties with government officials who lobbied their interests. Thus, Bitcoin as an idea of a possible alternative, digital cash system had been created. It is the first product running on a blockchain technology which represents a public ledger system preventing the double spending problem by proof-of-work algorythm (PoW). Each transaction of bitcoin from one user to another are written into the blocks of the blockchain, where the last transaction of the previous block leads to the first transaction of the next block. Once a block of 1 megabite reaches the maximum amount of transactions, it is closed forever and a new block starts. Bitcoin’s PoW is an algorithm where hundreads of computers around the world are proving the transactions and making them valid by solving complex mathematical equations. Thus, the network exists completely decentralized on hundreds of computers around the world which supply the network with computational power. As an incentive, they are rewarded with small amounts of Bitcoin for every proven transaction. The amount of Bitcoin created (a.k.a mined) through every transaction is divided by two (a.k.a. halved) 210.000 blocks. The total amount of possible supply of Bitcoin is limited to 21 million.
Price.
The price of Bitcoin is extremely volatile. Since its inception, we are currently in a forth bull market in each of which its price has increased on average in 17 times from its previous peak and also saw numerous retracements of 30–50% during the run. When the bull market ended, the price fell down by ca. 80%. Generally, the price is of course defined by demand and supply. Given the rising demand in the last year, especially by financial institutions and corporations, as a hedge against the inflation risk caused by extensive governmental spending and the rising corporate debt, the price of Bitcoin has risen significantly. At the same time, its clearly defined supply of 21 million, as well as halvening mining make it a perfect deflationary asset — if it gets adopted (which is quite obvious now), the price will always go up in the long-term.
Returns.
Being highly volatile, Bitcoin can have enormous price swings and, thus, appreciation or depreciation in the short- to mid-term — if you are lucky enough to trade it successfully, your returns can easily reach 1000% per year. At the same time, there are numerous rapidly growing fintech startups, such as BlockFi, offering staking services for Bitcoin, where you can earn around 5% annual interest for staking your Bitcoin on their accounts, as well as taking loans in cash while using your crypto as a security. I truly believe, such companies will have a crucial role in the future financial system.
Liquidity.
Bitcoin can be bought and sold easily in seconds on various exchanges, such as Binance, Kraken, Coinbase, etc. Furthemore, you can send your Bitcoin to any other wallet at any time of the day, on any day of the year within some minutes and at a very low cost.
Supply.
The supply of Bitcoin is defined as 21 million. There will never be more. Furthermore, halvening reduces the supply of newly mined Bitcoin every four years. At the same time, lots of people had lost the private keys to their Bitcoin wallets which means their Bitcoin is lost forever. This makes it one of the most limited assets in the world.
Risks.
There are several risks related to Bitcoin. Firstly, it is highly volatile — if you happen to FOMO-buy (fear of missing out) it at the peak, it may happen that its value decreases by some 85% and can stay there for a year or two. Secondly, it is still considered to be unregulated and some believe governments will ban it making its usage illegal — the fear spread by the recent announcement of China about banning Bitcoin mining created a huge selling pressure. So far, China has announced it several times but it never happened — draw your own conclusions. Thirdly, there are a lot of concerns about the rising consumption of energy consumption by the Bitcoin miners and its impact on the environment. The reality is, that at least 2/3 of all mining facilities already use reneweble sources of energy, such as hydro-electricity, or wind energy.
Regulation.
Bitcoin is not strictly regulated yet. It is designed to be an ultimate asset, which works cross-border and regardless of governments. However, as its adoption is growing, and more and more publicly traded companies are putting it on its balance sheet, it is clear, that the existing international accounting practices, such IFRS and others, should be further developed to include Bitcoin regulation. Currently, the existing regulation is limited to definition of taxation of realized profits from buying and selling Bitcoin as well as selling Bitcoin that was mined. Some States in the US and some other countries, such as Malta, create incentives for crypto-mining and for the industry in general, but these cases are rather separated.
Now let’s derive conclusions!
In my opinion, Bitcoin is an ultimate asset class and outperforms real estate and let’s have a look at conclusions in every category.
- Price. When it comes to price, this is the only point when real estate looks to win… at first sight. The price of real estate is more stable which is less risky. At the same time, I strongly believe, that people will invest less in real estate as a store of value and a source of passive income, since its is less liquid and it has maintenance costs. Once people realize that, the price of real estate will go down, since the capital will simply outflow into Bitcoin, which is easier to divide, sell, transport, and has almost zero maintenance/storage costs for the end-user. Therefore, Bitcoin is a clear winner in this category.
- Returns. This category is hard to compare since it highly depends on the type of real estate. If it is an object which in a very exclusive location which you rent out short-term, you can often reach something like 10% yield per year. This is currently absolutely not the case for Bitcoin, since its stakin rates vary somewhere at 5–6% on different platforms. At the same time, taking into account the maintenance and repairing costs, as well as Bitcoin’s appreciation potential, partially also by the capital outflow out of real estate, if you invest in Bitcoin now your long-term returns will disproportionally overexceed the possible returns from any kind of real estate.
- Liquidity. Bitcoin clearly is more liquid than any real estate object — you can buy or sell it on numerous crypto-exchanges in a matter of seconds.
- Supply. Also here Bitcoin outperforms real estate — there will never be more Bitcoin than 21 million. At the same time, a multi-store skyscrapper can be built on a plot where there was a single-family house for centuries — check how tall and thin buildings are being built in Hong Kong, e.g.
- Risks. The risks related to these asset classes have different nature and it is hard to compare them. On the one hand, you can forget your wallet-keys and your Bitcoin will be gone forever. On the other hand, your house can burn down or be bombed. What remains as a fact — in case of a war in your location, you can easily take your hardware wallet with your keys with you, whereas your house will need to stay. Draw your own conclusion.
- Regulation. For now, real estate is regulated better and, on the one hand, it is more secure for the investors. At the same time, as I have already mentioned, it is regulated differently in different countries, whereas Bitcoin is the same everywhere. Furthermore, if Bitcoin will be banned in one country, you cannot really stop people to use it — this is why it will most probably have some internationally unified regulation which will help its global adoption.
Having this said, I would consider such investments as Bitcoin before buying a yet another real estate object as a store of value. Furthermore, the impact of Bitcoin on society will be much greater than just becoming an another asset class and is yet to be discovered.
Disclaimer: Cryptocurrencies are speculative and highly volatile. Invest as much as you can afford to lose. I, as author of this article, own Bitcoin and other cryptocurrencies. The opinions represented here are solely of my own and are not aimed to give financial advice.
